Takeaway: Please join us for a flash call on JCP today at 1:00pm. We'll take an in-depth look at why we'd play the other side of the JCP = zero call.
Please join us for a flash call on J.C. Penney (JCP) today, September 27th at 1:00pm EDT. The call will take an in-depth look at JCP and why we would play the other side of the 'going to zero' trade.
- Toll Free Number:
- Direct Dial Number:
- Conference Code: 798797#
- Materials: CLICK HERE (slides will download one hour prior to the start of the call)
We'll Take The Other Side of The 'Going To Zero' Trade
This is not for the faint of heart, as earnings are non-existent, there's a lame duck CEO, no square footage growth, and the average American probably could care less if JCP exists or not. But everything has a price - even JCP.
Almost All of Its Problems Are Fixable
Apparel retail might not be the best business in the world, but it is one that allows you to shake the etch-a-sketch clean every 13 weeks. Our work shows that JCP's problems have been largely due to pricing, lack of promotions, and the omission of product that the consumer had otherwise grown to rely upon.
There's a Steep Gross Margin Opportunity
Johnson took away $2.5bn in revenue at a 48% GM, and substituted with less than $1bn of 33% GM product. There's over 500bp in GM recovery right there.
This Equity Offering Solved More Problems Than It Caused
As tight as cash seemed to be, JCP did not need this deal now. It was poorly managed/telegraphed. But the reality is that liquidity is no longer a near-term risk. This makes the 'going to zero' call really tough to play for. It also takes risk of factoring companies limiting goods out of the equation. Lastly, it accelerates the quality and quantity of CEO candidates.
Another Way To Play the JCP Recovery is to Short KSS
Our work suggests that KSS stole $800mm from JCP, and there's nothing permanent about that share shift. JCP is gunning for the business, and whether it succeeds or not, it will hurt KSS while it tries.
Takeaway: Nike is making ailing US retailers as well as its global competitors (aka Adidas) look downright silly.
This note was originally published September 26, 2013 at 20:28 in Retail
What’s there to say about Nike’s quarter? We’re surrounded left and right by weakness in US retail, and yet Nike comes out and prints a quarter of Champions.
NKE printed top line growth of 8%, and an acceleration in futures to +10%, with a nice balance of 7% growth in units, and 3% increase in price. We saw +120bp improvement in gross margins, which was far ahead of our above-consensus estimate – as pricing initiatives are being met with very little resistance, and raw materials costs are coming in below plan. SG&A was flat for the quarter, which is largely due to comparisons against event spending vs last year. But still, the growth algorithm is inarguable…sales +8%, gross profit +11%, and EBIT +40%. EPS came in at $0.86, well ahead of our estimate of $0.82 and the Street at $0.78. Inventory looked great as well, growing 6% -- below the rate of sales for the 5th quarter in a row.
You might say that Nike naturally sidesteps the US retail malaise due to the fact that it is a global company. But then why did Adidas – its closest global competitor that has a nearly identical scope, reach and mix outside of the United States – put out an announcement on September 20 taking down expectations for the quarter and the year due to weak sales globally, particularly Russia (which Nike highlighted as a strength this quarter), and golf (this was also weak for Nike, to be fair). This juxtaposition simply highlights how well Nike is managed relative to its peers.
We’re taking up our estimate to $3.25 for the year (20% EPS growth). We think that Nike is being conservative with its expectation for only 50bps of improvement in gross margins for the year, and although we’ll start to see more normalized levels of SG&A spending, the reality is that a high-single-digit growth rate in sales with 100bp+ in gross margin improvement is nothing to shake a stick at. Mid-high teens EPS growth on top of 25% ROIC makes Nike every bit worthy of its 20 forward multiple (and then some). Nike’s still a core holding any way we cut it.
We’ll return with a more thorough deep dive after Nike’s analyst meeting in two weeks.
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Client Talking Points
Brent is down -0.5% this morning and testing our long-term TAIL risk line of $108.57 support for the secondtime this week. There’s potential for a big breakdown here if the US Dollar can find a way to fight off Ben Bernanke. Down Oil is obviously a good thing for US consumers and economic growth.
Make no mistake: Vladimir Putin does not like the Petro Dollar being under pressure. Neither does the Russian stock market. It is down -1.4% this morning leading the losers. It is down at -2.8% year-to-date for the RTSI. You can bet your ruble that I’d like to see more of that.
The 10-year Treasury yield is still hanging out there in no man’s land at 2.62%. Our TREND support is the line that matters most at 2.55%. The immediate-term TRADE resistance is 2.74% now. Next week's U.S. employment report should be a rather decisive factor in determining where it goes next. We are watching bonds and Ben Bernanke very closely.
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Top Long Ideas
WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.
Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward. Near-term market mayhem should not hamper this trend, even if it means slightly higher borrowing costs for hospitals down the road.
Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks. T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.
Three for the Road
QUOTE OF THE DAY
STAT OF THE DAY
A shutdown of the U.S. government would reduce Q4 economic growth by as much as 1.4 percentage points depending on its length, economists say, as government workers from park rangers to telephone receptionists are furloughed. (Bloomberg)
Kimberly Clark remains one of our favorite names on the short side as a difficult environment is pressuring volume growth, input costs are accelerating, and macroeconomic factors have rendered the stock far less attractive as a source of yield. In addition, the market is still demanding 17x forward earnings (which are likely too high) for the stock. We expect investors to pay up for organic sales-driven growth, not share repurchases and cost savings. The long-term opportunity for the company, particularly in emerging markets, is impressive, but we would wait for 3Q and possibly 4Q earnings to pass before getting behind the stock.
Ahead of 3Q EPS on 10/22: Ahead of earnings, we are highlighting the following factors as most important to us changing our fundamental view from negative to neutral or positive:
- Organic sales growth accelerating
- EBIT growth re-acceleration
- FX impact easing into 4Q
- FCF growth (following a -2.1% decline in 2Q)
- Positive commentary or data points on innovation pipeline
Top-line Concerns: The Company’s growth profile is hampered by difficulties in developed markets such as Korea, Australia, and the U.S. In the U.S., the higher margin personal care business registered negative volume growth despite negative product mix in 2Q, which was a concern for investors.
Cost Savings: The Company has driven a tremendous amount of cost savings - $1.9 billion - out of its business over the past nine years, largely driven by a focus on the supply chain. Two-thirds of the savings have been generated by “lean manufacturing practices” and the remainder has been driven by the company’s global procurement organization. Management is guiding to a $300-350 million annual savings figure (from $250-300 million prior estimate).
At the Barclays Back to School conference, CFO Mark Buthman stated, “the more savings we drive, the more that we find”, as an explanation for the increasing dollars being slashed from the company’s budget. While adding efficiency to a business is good news for shareholders, we do not view cost-cutting as a growth business in and of itself. The company’s organic sales growth is of much greater importance and evidence of an improvement on that front is necessary for us to get comfortable with owning the stock. As the chart below highlights, recent EBIT growth has increasingly been driven by cost savings.
Input Costs Likely Accelerated in 3Q: The acceleration in oil and pulp prices from 2Q to 3Q implies that raw material inflation is likely to be a greater drag on operating income in 3Q than it was during 1H12.
Rates Rising: We have belabored this point, but it is worth emphasizing again. A rise in interest rates from current levels, driven by strong employment data, Federal Reserve commentary, or other market factors, could drive capital further from the consumer staples sector. While correlation is not, nor does it imply, causation, it is interesting to note that during the 2009-2012 period, when quantitative easing measures from the Fed dared investors to chase yield, consumer staples traded at a strong inverse correlation to 10-year Treasury yields. The inverse correlation of KMB to the 10-year yield was, in fact, even stronger during the 2009-2012 period, which may indicate that KMB was even more “bid up” by fundamental-agnostic investors, in pursuit of yield, than the XLP.
Quantitative Levels: KMB is in bearish formation with intermediate-term TREND resistance at $98.23.
Takeaway: JCP deal -- how can you stay short from here? JCP/factoring fear is not moot -- espec w pos comp trends. FNP/Kate Saturday. JNY Loses KKR.
JCP - J.C. Penney Offers 84M Shares to Raise Capital
- "[JCP] could raise $1 billion in the form of a stock offering. The company said after the equity markets closed Thursday that it will offer to the public at least 84 million shares of its common stock, and that it intends to give Goldman Sachs, the underwriter, a 30-day option to purchase an additional 12.6 million shares of common stock."
- "Penney’s said it will use the net proceeds from the offering for general corporate purposes."
- "The public offering comes after [Mike Ullman]...told investors Wednesday that the company 'wouldn’t raise capital until the end of the year' and that they should 'not believe that circus you hear about,' according to one participant."
- "Struggling retailer [JCP] said it expects to end the year with about $1.3 billion in cash, excluding the proceeds from a share offering."
- The offering is priced at $9.65/share
Takeaway: The worst kept secret on Wall Street. We still contend that JCP is doing this deal because it wants to, not necessarily bc it needs to. Now it will have well over $2bn in cash at year end plus another $1bn in cash it could raise through monetizing assets and tapping revolver and accordion. Is there dilution with the deal? Of course. But the ‘JCP going to zero’ short case is very difficult to make at this point. We still like JCP as we think that the damage done over the past two years is fixable. We’re hosting a call later today to discuss our thoughts on the name and take Q&A.
JCP - J.C. Penney Projects Positive Comp Trends
- "[JCP]...said, 'The company still anticipates it will experience positive comparable-store sales trends coming out of the third quarter and throughout the fourth quarter of 2013.'
- "Penney’s also noted it was 'pleased with its progress thus far' in its turnaround efforts and in the 'traction' its initiatives are starting to achieve."
- "The retailer noted that 'it is starting to see greater predictability in its performance across many areas.'"
- "'The company continues to be encouraged by improvements in purchase conversion both in store and on jcp.com, primarily due to being back in stock in key items and sizes the customer expects to find at J.C. Penney...Overall sales on jcp.com continue to trend double digits ahead of last year.'"
Takeaway: This came on the heels of several firms commenting that comps were negative and would stay that way. Guess not.
JCP - Penney suppliers face credit squeeze as fears mount
- "So-called 'factoring' companies that finance clothing deliveries to Penney are tightening credit terms, shortening payment windows and tacking on extra surcharges as worries about the retailer’s business mount, The Post has learned."
- "Commercial-lending giant CIT is approving Penney orders selectively and has increased its surcharge to 2 percent, despite holding a $100 million letter of credit from Penney that the chain had tried unsuccessfully to claw back this summer, sources said."
- "Wells Fargo, which also has a large factoring arm, is still supporting Penney orders, although the bank has acquired a financial hedge worth $50 million in the event of a Penney bankruptcy, according to a source."
- "The clampdowns — which in some cases have also shortened payment windows to 30 days from 45 to 60 days — are more opportunistic than a signal of real worries about a potential bankruptcy filing this year, according to insiders."
- "However, an insider noted that the firm, which is raising its own surcharge to 2 percent, doesn’t believe a Penney bankruptcy filing is 'imminent' this year."
- "Other firms that are raising fees including Capital Business Credit, which is asking for a 3-percent surcharge on some deliveries, according to sources."
Takeaway: There’s a new story about JCP battling factoring firms just about every month. At best half of them are true. Also keep in mind that factoring firms breed fear. When the public gets concerned about business trends and liquidity by reading the Post, factoring firms gain leverage to raise fees. The equity deal this morning shoots this in the foot, as factoring firms have zero leverage when cash balances are going up by $1bn.
JNY - KKR Drops Out of Jones Hunt
- "Private equity giant KKR & Co. has dropped out of the hunt for The Jones Group Inc. The investor had teamed up with Sycamore Partners in a bid to buy the company. A source familiar with the situation said Thursday that Sycamore was still in pursuit, with managing director Stefan Kaluzny now taking the lead. Although KKR is on the sidelines, the firm might still have a role to play down the line, the source said."
- "The process is now centered on determining 'what people really want and what they will pay' and 'figuring out the pathway to a transaction,' said one source."
- "Although a sale of the entire company would be simpler, Jones might ultimately get a better price if it sells the business off in parts. And that dynamic appears to have played a part in KKR’s departure."
Takeaway: This is a sign of the times. Recall that FNP had the top suitor for Lucky and Juicy both walk out earlier this week.
FNP - West Third Street Keeps Independent Flavor
- Kate Spade Saturday, the younger concept collection from New York brand Kate Spade, just recently opened a store on Los Angeles’ West Third Street, generally considered to be a thoroughfare of independent boutiques.
RUE - rue21 discloses comps
- "rue21...is disclosing the following information , which has not been previously reported and may be provided to prospective lenders in connection with the financing of the transactions contemplated by the previously announced merger agreement, dated as of May 23, 2013…"
- "The soft sales pattern seen in Fiscal August is continuing in the third quarter to date with comparable store sales down 9.5% through September 24th. To date in Fiscal September, which began September 1, 2013 and will end on October 5, 2013[ 9/1-10/5], comparable store sales were down 12.8%. Compared to the comparable periods of last year, total sales for the third quarter to date are up 2.3% and for Fiscal September to date are down 1.3%."
L - Joe Fresh Taps Mario Grauso
- "Joe Fresh has hired Mario Grauso as chief operating officer, a new position geared to help put the brand on the global stage."
- "Joe Fresh is currently distributed only in North America and, in the past few years, has focused on opening stand-alone stores in Canada and the U.S. and rolling out shops inside J.C. Penney stores."
- "Grauso has more than 20 years of experience in the fashion industry. Most recently he was president of the Vera Wang Group, beginning in 2009."
TGT - Attention Amazon Moms: Target.com Wants You
- "Target.com announced the launch of a subscription service that allows parents of infants and toddlers to put aside some of their worries and save money by ordering items such as diapers, formula and wipes on a recurring basis."
- "Like the Subscribe and Save program on the Amazon Mom page, customers of Target.com can now order from a group of items and have them delivered to their doorsteps at regular intervals, from four to 12 weeks. Target says consumers who participate in the program can save up to 15 percent and receive free shipping. "Those who pay using Target's REDcard will save an additional five percent."
- “A total of 150 items from Target's up&up private label are included in the program, as well as national brands including Enfamil, Huggies, Pampers, Seventh Generation and Similac."
CROX - Crocs hires Nike director Tim Lyons to lead European retail operation
- "Lyons, who is based in The Netherlands, is responsible for Crocs’ 115 owned stores and 98 franchise stores across 45 countries."
- "He was previously director of Nike’s factory stores throughout western Europe."
Takeaway: Going from Nike to Crocs? Seriously? We have to do the obligatory double-take on CROX when they start attracting that kind of talent.
Bi-Lo, Winn-Dixie parent files for IPO
- "The parent company of Bi-Lo and Winn-Dixie supermarkets, Southeaster Grocers, has filed for an initial public offering."
- "The shares are expected to be offered by Southeastern Grocers, and the number of shares to be offered and the price range for the offering have not yet been determined."
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